Stronger Third Quarter Makes Outlook Weaker

The U.S. economy last quarter grew at one of the speediest paces so far in this recovery. But the revisions in Thursday’s gross domestic product report raise worries about production going forward.

The Commerce Department said real GDP expanded at a 2.7% annual rate last quarter, better than the 2.0% reported a month earlier. Only two other quarters have seen better growth rates since the recovery began in mid-2009.

The source of the better growth, however, isn’t good for the outlook. Almost all of the revision came from the inventory sector. Inventory contributed 0.77 percentage point to GDP growth last quarter, a swing from the 0.1 point drag reported a month ago.

The problem with growth coming from inventory accumulation is that businesses headed into the fourth quarter with extra goods on shelves or in warehouses. If demand isn’t solid enough to move that merchandise out the door, an overhang of inventories will mean less orders and production.

Those production cuts might come in the fourth quarter or they could be a drag in early 2013, just as some type of fiscal restraint (higher taxes or federal spending cuts) filters through the economy.

How important were inventories to GDP? Excluding them, real final sales grew 1.9% last quarter, down from the 2.1% reported earlier and not much better than the 1.7% rate of the second quarter.

The unexpectedly high rate of inventory building caused economists at Goldman Sachs to lower their estimate of fourth-quarter GDP. They wrote in a research note, “We believe that underlying momentum going into Q4 was weaker than we anticipated. As a result we revised our Q4 GDP tracking to 1.5% from 1.7%.”

Demand that weak won’t generate many new jobs.

The wild card in the inventory-demand relationship is the Northeast’s recovery from Sandy’s destruction.

Businesses hit by the storm have to restock or rev up production to recoup what was lost in the storm. Families are also engaged in their own inventory accumulation. That could mean something as minor as replacing food spoiled when a freezer had no power, or as major as restoring the items of an entire household–and the house itself.

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